IEA: Huge Oil Price Spike Inevitable

Three years of drastic cuts to upstream spending because of the meltdown in oil prices could result in a shortage of oil supply in a few years, according to a new report from the International Energy Agency.

When oil prices collapsed in 2014, oil producers quickly took an ax to their spending. Global oil and gas investment dropped by a quarter in 2015 and by an additional 26 percent last year, the IEA estimates. A long list of projects, particularly very large ones, were put on ice.

Because many of these projects take years to develop, the sharp slowdown between 2014 and 2016 could result in very few sources of new supply hitting the market towards the end of the decade.

To be sure, supply is already coming back. The U.S. has added more than 500,000 bpd since last summer, and shale drillers are ramping up activity. The IEA says that the shale industry achieved cost reductions of about 30 percent in 2015 and 22 percent in 2016, making the average shale well more profitable today than it was before the downturn. That is already leading to a rebound.

Moreover, the IEA thinks that even the revival of U.S. shale at lower prices won’t be enough to head off a supply shortage by 2020. The pipeline of new projects is too small.

Meanwhile, demand will continue to grow, eventually overtaking supply. The IEA projects global demand to reach 104 million barrels per day (mb/d) by 2020, with the “call on OPEC” reaching 35.8 mb/d, up from 32.2 mb/d last year.

The market may ask for much higher supply from OPEC, but that would force the group to burn through its spare capacity, which could shrink to well below 2 mb/d. Spare capacity – the ability to ramp up or down supply on short notice – has been one of the key cushions to the oil market for decades. Knowing that Saudi Arabia could plug any supply gap in a pinch helped reduce oil market volatility, and also reduced the risk premium that would hit the market when unforeseen geopolitical flashpoints inevitably cropped up.

The IEA warns that unless a wave of new upstream projects are given the greenlight by exploration companies, OPEC’s spare capacity will fall to low levels and oil prices will rise sharply.

One of the more eye-opening predictions from the IEA is that oil demand will continue to rise without interruption. The agency noted that global oil demand grew by a whopping 2 mb/d in 2015 because of low prices, then by another strong 1.6 mb/d in 2016. Moving forward, demand rises steadily, year after year, by an average of 1.2 mb/d through 2022. India takes over as the largest source of demand growth, a mantle long-held by China. Related: Oil Prices Hold Steady Ahead Of Inventory Data

The IEA, unlike a growing chorus of analysts, thinks that electric vehicles might only have a marginal impact on demand, slowing consumption growth but ultimately not reversing it. On top of that, oil demand will grow in various sectors not related to passenger vehicles, including freight, marine transit, and aviation. “For all these reasons, the much-discussed peak for oil demand remains some years into the future,” the IEA wrote.

So we have rising demand and a shortage of new supply. But, surely U.S. shale, with its falling breakeven prices and resurgence at $50 per barrel can meet the supply gap? The IEA does think that shale will see significant growth, rising by 1.4 mb/d through 2022, assuming oil prices at $60 per barrel. If prices rise to, say, $80 per barrel, then U.S. shale could see growth of 3 mb/d. But the IEA’s working assumption is that all non-OPEC countries together contribute an extra 3.3 mb/d of supply over the next five years.

The problem with that figure is that demand is expected to rise by 7.2 mb/d over that same timeframe. The end result will be a strain on OPEC supplies. In light of these numbers, the IEA issued a warning. “[W]e are emphasising an important message: more investment is needed in oil production capacity to avoid the risk of a sharp increase in oil prices” by the early 2020s.

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Why is it that most articles and analysis, when they take shale into consideration they only mention the US?

Russia, Argentina and others have even greater deposits and they are only now beginning to exploit them - utilizing the US knowhow.

Russians already have some infrastructure in place and are already producing significant quantities of crude this way.

Argentina has recently enacted laws to make it easier for foreign companies to do the exploitation, but Argentinians rarely pass on an opportunity to shoot themselves in the back, so their oil development is still very iffy.

The bottom line is that shale production is far less complicated and capital intensive than say deep water exploration, but there too have been major cost adjustments. For example, in 2013 it was virtually impossible to book a deep water drilling platform - they were all working at several hundred thousand dollars per day. Today you can get any number of such platforms and for a fraction of what it cost back then . . .

Bill Simpson on March 08 2017 said:

Globalization, enabled by the invention of the standard steel shipping container, a US invention which drastically lowered shipping cost, has enabled a couple of billion people to escape dire poverty over the last 30 years. They have become rich enough to begin to consume ever greater quantities of petroleum products. So the demand for oil will continue to rise for another few decades.
No way the oil supply will be able to do that, so expect big financial problems, starting between 2022 and 2025.
If Venezuela wasn't such a mess, we could push that date back by almost a decade. But that won't happen. Canada will be in good shape because the oil sands will be needed, and Trump will let them build as many pipelines as they wish, so long as they use US produced pipe inside the US. They need to get their pipes down before he leaves office, and while nearly all the state governors through the center of the country are still Republicans.

Tom on March 08 2017 said:

I see what the article says. However, the IEA has traditionally not been very good in forecasting how renewables will develop going forward. And I don't see any of the IEA's assertions reflected in oil futures' prices.

At the same point in time, efficiency gains in oil consuming industries and environmental policies are doing their share to curtail demand.

Again, I see what the IEA predicts for 2020 and beyond. However, I'm not convinced they got it all right.

JHM on March 08 2017 said:

The futures markets do not seem to support what the IEA is saying about tight supplies in early 2020s. Brent futures in particular have been steadily falling over the last three to four months.

So essentially, the IEA is urging investors to take out a huge bet against the futures markets. Is it responsible to encourage producers to develop oil supplies on an unhedged basis? Or are they saying retail investors should speculate on futures?

In my view, the best way to bring stability to the oil market is for producers to proceed on a well hedged basis. If you like what the futures market is offering in 2021, fine, proceed with your project. If futures are too low for your project, then wait.

To do otherwise risks extending or creating a whole new oil glut. Between the risk of high oil prices in the early 2020s or a massive oversupply situation, IEA seems bent on making sure producers lose money. Consumers, for their own part, have many options to hedge against high oil prices, buying a fuel efficient or electric vehicle being chief among them. So let consumers worry about high oil prices, and let oil producers worry about overproduction. The market will sort this out.

Karthik Srinivasan on March 08 2017 said:

OPEC and Russian spare capacity has gone up considerably because of the production cuts. US and other shale deposits can more than make up for reduced investment in offshore production. I think the IEA is being overly pessimistic on a supply crunch and if OPEC doesn't extend its deal, prices will plummet (particularly as the record high speculative long positions are unwound).

Frank on March 08 2017 said:

I think I'll wait until this glut is proven diminished and IEA starts under-estimating renewables growth by less than 90% year-over-year. Perhaps then I'll be open to the idea of price surge.

Sue on March 08 2017 said:

I really dont see that there will be an incentive to increase production until prices rise to meet the cost of producing the product

Tom on March 09 2017 said:

The sheer level of oversupply in storage and in production capacity will take at least another 3 years to balance. Oil won't be over $60 until 2020 at the earliest and we're going to hit prices at or below $40 by May which will last through early 2018 as OPEC surrenders, leaving everyone to pump into oblivion. Only after bankruptcies and gnawing starvation of new investment will the market begin a balancing process.

Marc Johnson on March 10 2017 said:

History says you should not use the futures market as an indicator of future prices in years far out into the future. If you go back to 2003 the futures market for 2007 didn't have a price that was even half the 2007 actual price. Same way with early 2014 pricing. It was pricing early 2016 at multiples of the actual price. Outer months on the futures market is the perverbial red herring.

Peter on March 10 2017 said:

Estimates are just that. I think the IEA has proven inaccurate in their ability to definitively forecast. Additionally, it is in their interest to hype up production and be wrong (i.e. Better to have than have not).
Two significant factors: climate change (suppressing fuel consumption and less heating oil) and renewables are exponentially more scalable and apt to grow at a much faster rate than other forms of energy. Solar in the US surpassed all other new energy installation in 2016... I also think electric and hydrogen vehicles are going to hit a tipping point in 2019... India is already prioritizing and legislating to go all electric. EU countries are accelerating electric vehicles and considering legislation to outlaw the ICE by 2030. CA is looking increase legislation and renewable goals.
Oil will fall to less than $40/barrel by end of summer 2017 and stay there...

Ripsnort on March 13 2017 said:

That's only a wish on your part Nick.

Guym on March 13 2017 said:

EIAs estimates of a 500k barrel increase, are just that, an estimate. It has actually been flat, at best. Texas RRC shows flat, Bakken is down, and GOM figures trend down, or at best, flat.

brett ingham on March 22 2017 said:

It seems to me that the real key to future oil prices is based upon the average cost of production for the demand in the given year of consideration. Does anyone know how much it will cost to produce 100 bpd for 2017?